July 3, 2007
Taxes and Takeovers
Before Congress charges into new taxes on hedge funds and private equity funds it ought to pause and consider its record on special taxes aimed at takeovers. Beginning in 1969 with section 279 and continuing to 1989 with section 163, Congress has attempted to discourage takeovers with various tax provisions aimed at debt financing. We also have special rules for golden parachutes and pension plan cash-outs and special rules for the carry-over (and carry-back) of tax attributes. All the rules need careful re-examination; most of them are either easily avoided and/or have consequences in deal structuring that are counterproductive. Now we have Congress ready to impose special rules on partnerships in which a managing partner (the hedge fund firm or private equity firm) earns a portion of the profits (the "carry") to attack another form of an equity acquisition or takeover. Once again the results will be the same. Deal structures will change to meet the new rules and the new structures will cost more to create, but deals will still happen and tax collections will increase only marginally once the clever planners take over. More rules and new regulations will be needed to stop the new deal forms or, as is usually the case, we just resign ourselves to the new forms.
The new proposals themselves confuse reporters (and the public). One reads commonly in the press, for example, that one bill pending in Congress seeks to have publicly-traded master limited partnerships (now taxed at 15%) "taxed like corporations" (at 35%). Publicly traded limited partnerships are now taxed as separate entities and are now taxed at 35% on ordinary income; like corporations, such partnerships are taxed at 15% on long term capital gains (the business of equity based investment funds). If a hedge fund was a corporation it would pay 15% on investment gains. And, by the way, most corporations have an effective tax rate, even on ordinary income, at closer to 18%. In essence, some in Congress want special rules for managing partners in partnerships. Congress wants managing partners to pay ordinary income taxes on their investment gains, now taxed at capital gains rates. Corporate managers who receive at-the-money options in lieu in all corporate investments (the equivalent of a "carry") would be better off under such a rule. Publicly traded hedge funds will incorporate on the IPO. There is no substitute for scrapping the double tax system and designing a flow through tax system for all business entities. It would stop all the games and enable Congress to level whatever rates it wants on business income at the individual level.
July 2, 2007
Supreme Court and Business
It was inevitable -- the Supreme Court is under attack by the popular press. The Court's decisions on social issues has upset the fair minded. One of the attacks is interesting; separate the Court from its political base by labeling it pro-business and anti-shareholder. Even conservatives are pro-shareholder. The attack is transparent. Shareholders as well as businesses are better off when frivolous litigation is harder to bring. The balance between legitimate and illegitimate lawsuits is important to shareholder value. The court, by adjusting the balance, if it is correct, is not anti-shareholder; it is pro-shareholder. There is no evidence that the Court is biased toward or corrupted by big business; such challenges after the public legitimacy of the court and should not be lightly made, especially to serve other social purposes. We have come through an era when many have come to believe that the court, like a kindly grandfather, is the repository of whatever is fair. Jurisdiction, separation and balance of powers, executive or legislative prerogative, federalism, and limited judicial factfinding are concepts for wimps; the court should declare what is just and fair and tell everybody else to stuff it. If the Court does not do what you think is fair (long statutes of limitation for discrimination actions), scream about it and impugn the integrity of the justices who do not do what you want. That's the ticket.
The Roberts court has a better sense of what the Court is and should be; now we need the press to educate the public not to mislead them.
Bell Canada Buyout
The 51.7 billion (Canadian $$) buyout for Canada's largest company is another one that smells. The primary buyout group includes the Ontario Teacher's Pension Plan. First, their involvement meets the 47% cap on foreign ownership under Canadian law that limits other United States buyout groups from actively bidding. In other words, they are getting it cheap and if the Canadian Parliament lifts the cap they can immediately resell for a profit. Second, the what is a teacher's pension plan doing with so much money in one deal? Using teachers pension money to speculate on a buyout makes sense only in very small amounts. Third, the bidding process was very secretive and led to speculation about a broad that favored a bidder that would protect existing management. The Teacher's Pension Plan managers have been publicly very complimentary of existing managers. It does not take much in an action to favor one bidder over another, managers have advisers that know the tricks; a secretive auction makes the temptation overwhelming. We need to get better control over the conflicted role of existing management in buyouts, Canadian and American.